Follow the leader: Can Bush live up to Reagan?

June 14, 2004

By David R. Francis

Like it or lump it, Ronald Reagan left an indelible mark on American economics. His passing has resurrected a debate on the merits of huge tax cuts and resulting deficits - issues crucial to the nation's future.

Some Republicans cheer every tax cut. Vice President Richard Cheney said Reagan proved deficits "don't matter," according to a book quoting former Treasury Secretary Paul O'Neill.

With the White House trying to wrap President Bush in the mantle of his famed Republican predecessor, some economists have taken a closer look at Reagan's history. With his massive 1981 tax cut and defense buildup, Reagan created the largest deficits since World War II. Then he raised taxes three times to undo some of the deficit damage.

By the time Reagan left office, the nation was in better economic shape than when he found it. A deep recession had turned into vigorous recovery, inflation was tamed, and deficits as a share of the economy had fallen dramatically.

One Reagan legacy was not tax cuts, but a tamer brand of what was once a fringe idea: supply-side economics.

"It has become conventional wisdom," says Martin Feldstein, chairman of Reagan's Council of Economic Advisers (CEA) in his first term. "Everybody understands that incentives matter. Very high tax rates will discourage ... economic effort."

The theory works this way: Whenever the proportion of personal income taxed is shrunk, some people will work more hours and harder, save more, take more risk, and invest more. So when marginal tax rates are cut - the top rate for the well-to-do dropped from 70 percent to 28 percent under Reagan - it can boost the economy.

"The supply-siders had a good point," says Beryl Sprinkel, chairman of the CEA during Reagan's second term in the White House. And, he says, supply-side economics is "alive and well" today.

Many foreign nations, industrial and developing, have accepted the Reagan administration thesis that high tax rates are damaging to their economies and have slashed marginal rates - the tax rate on the last dollars earned by individuals.

The debate today among economists is over how much of a punch those tax cuts pack and for how long. This is where the ideologues run afoul of history.

After Reagan's massive tax package of 1981, including a phased-in 23 percent cut in individual tax rates, one White House economist, Arthur Laffer, held that the cut would so stimulate output that new tax revenues would fully offset the revenues lost by the tax cut.

Mr. Feldstein, now at Harvard University in Cambridge, Mass., and Mr. Sprinkel, now retired, agree. So do recent studies by the Congressional Budget Office and Federal Reserve.

But economic studies do show, says Feldstein, that lower marginal tax rates encourage married women to go to work or work longer hours. That's because they take home more of their pay - and have a choice on whether to work or not.

But the impact of a marginal tax cut on men and single females is small - a "wash," says Bernard Wasow, an economist at the liberal-leaning Century Foundation's Washington office.

In any case, Reagan did not follow the advice of the extreme supply-siders. Mr. Wasow notes that after the 1981 tax cuts produced a large federal deficit, Reagan collaborated with Congress to raise the average tax rate significantly in 1982, 1984, and again in 1987.

The result was that the 1983 deficit, which was the equivalent of a postwar high 6 percent of gross domestic product, came down to 2.8 percent of GDP when Reagan left office in 1989.

His successor, George H.W. Bush, raised taxes again in 1990. So did President Clinton in 1993. By then, none of the revenue losses from the 1981 tax cut remained, reckons Wasow.

Yet the economic collapse predicted by supply-siders in 1993 did not happen, notes Wasow. The economy boomed.

The deficit will run about 4.5 percent of GDP this year. The current president has made no move to raise taxes; rather, he wants to make his cuts permanent.

Whether that's bad or not depends partly on how rapidly the economy grows. Feldstein says that with a 3.3 percent real growth rate, the deficit would fall to 2.5 percent of GDP in five years. Wasow doubts that the budget picture will look that rosy, saying it depends on future tax decisions.

Whether Bush will follow the economic pragmatism of Reagan remains to be seen. "Bush II is an entirely different character" from Reagan, warns Chris Edwards, an economist at the libertarian Cato Institute.